Fiscal illusions are “errors […] that the political elite uses to reach its objectives” and these errors concern both “revenue” and “public expenditure.

I recommend this piece by Marco Valerio Lo Prete for London-based consultancy MacroGeo. The theme is the Italian public debt, which is now 133% of GDP. But in actual fact, the article is a good summary of the last forty years of Italian political history.

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Lo Prete, using data supplied by historian Guido Pescosolido, looks at the dynamics of Italian debt through time. Until recently, it only went above 120% of GDP twice: once, in the late 1800s and once in correspondence with the WWI military efforts. In both cases borrowing was driven by political factors: first, the country had to manage the public debts of the previously independent states absorbed by the newly-formed Kingdom of Italy (beginning with Piedmont’s, the state which conquered the rest of the Peninsula) and to finance public spending in order to foster top-down industrialisation and pay for colonial endeavours; second, obviously the war was a political decision.

But more recently, borrowing has been driven by the dynamics of democratic politics. “The central state fostered the illusion that more generous welfare and a larger public administration came free of charge. From 1971 onwards, public expenditure has been higher than public revenue for decades.”

Lo Prete explains this referring to Amilcare Puviani:

The “fiscal illusion” theory was hypothesized by Amilcare Puviani, an Italian economist at the turn of the 20th century, and far more appreciated in American thinking (for example by Nobel Prize-winning economist James M. Buchanan) than within the Italian intellectual debate. Fiscal illusions are “errors […] that the political elite uses to reach its objectives” and these errors concern both “revenue” and “public expenditure.

One way in which governments create and take advantage of fiscal illusions, according to Puviani, is a systematic preference for relying on borrowing rather than on higher taxes, as public borrowing is a less immediate and less obvious burden.

Since the end of the 1960s, public expenditure in Italy quickly grew without the central government raising enough revenue to balance it. Public expenditure rose from 33% of the GDP in the second half of 1960s to 41% of the GDP in 1975; with stable public revenue, the debt-to-GDP ratio rose from 38% in 1970 to 57% in just five years.ยป

There are understandable reasons why the Italian government spent so heavily in the 70s: besides the dominant ideology (a factor which was not unknown in other Western countries, too), the government had to cope with terrorism (in no other Western country did Marxist revolutionaries kidnap and kill a former prime minister) and wanted to buy the consensus of the public, charging their sons and grandsons. But no retrenchment ever followed, with the exception of efforts in the 1990s, to reduce the debt in order to comply with parameters to enter the common currency.